Updating Form ADV and Form U4

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Form ADV is not a stagnant document since it changes as an RIA evolves over the years. Typically, the firm’s personnel, assets under management, and its business model change from year to year.

RIAs should make certain that their Form ADV, as well as U4s for all registered individuals, are up to date. Because of the switch to the narrative Form ADV Part 2, securities regulators will be putting these documents under the microscope. Therefore, it is imperative that RIAs make certain these documents are current, consistent, and accurate.

As part of their full disclosure duty, RIAs and IARs must ensure that all material information contained in these documents is up to date. The materiality standard under the Investment Advisers Act is whether there is a substantial likelihood that a reasonable client or investor would consider the information to be important. This is a facts and circumstances test. According to Footnote 35 of the Amendments to Form ADV adopting release, the SEC does not believe it is “appropriate to specifically define or provide any bright line tests for what is and is not material,” since materiality depends upon the factual situation.

There may be severe consequences if an RIA fails to update Form ADV. Since failure to do so is a violation of Rule 204-1 under the Investment Advisers Act and similar state rules.

In addition, examiners routinely review U4 registrations ensuring that they are accurate, since investors rely heavily on them to evaluate an RIA and an IAR. The type of action taken by securities regulators will depend upon the kinds of inaccuracies found. Regulators will deal harshly with an RIA that intentionally provides misinformation on its Form ADV.

When to Update Form ADV

To avoid problems, RIAs must amend their Form ADV each year by filing an annual updating amendment within ninety days after the firm’s fiscal year end. An RIA should ensure that the firm’s annual updating amendment accurately reflects its current information. According to the IARD system, the annual updating amendment is referred to as a special amendment.

In addition to the firm’s annual updating amendment, RIAs must promptly amend their Form ADV by filing other-than-annual amendments if information provided becomes materially inaccurate. Examiners will be on the lookout for unreported changes in information, such as outside business activities that should be disclosed. The fact that an RIA is engaged in other business activities is important information for prospective clients to consider when choosing a firm.

If an RIA is growing, it is easy to see how Part 1A might become outdated. For example, an RIA must disclose how many employees the firm has. The RIA must also indicate how many employees perform an advisory function. Furthermore, the RIA must state how many employees are registered representatives of a broker-dealer. Even though this information must be updated, an other-than-annual amendment might not be necessary unless it is material. A huge change in these numbers might be viewed as material whereas minor fluctuations may not be.

It is also important to keep Part 1A schedules up to date and include updated information about disciplinary events. Schedule A asks for information about an RIA’s direct owners and executive officers. Schedule B requests information about the firm’s indirect owners.

Updated Information Should Be Consistent

Changes made to Form ADV Part 2 may prompt revisions to Form ADV Part 1. For example, outside business activities must be consistent in both documents.

Recently, the Texas State Securities Board took issue with an RIA, which stated in Part 1 that the firm charged fees based on assets under management. In Part 2, however, the RIA indicated that the firm shared fees charged by third-party advisors and did not manage any accounts directly. Sharing fees charged by a third-party advisor is not the same as charging fees directly based on the amount of assets managed.

Assets under management must be kept up to date. On April 7, 2011, the SEC instituted enforcement proceedings against an RIA that failed to make timely disclosures to clients. Among other allegations, the SEC charged the RIA with failing to disclose to clients and prospective clients all material facts regarding the financial condition of the firm that were likely to impair its ability to meet contractual commitments to clients. The RIA claimed it managed as much as $1.5 billion at various times. In fact, the RIA had roughly $9 million in assets under management.

The Commission also charged the RIA with failure to disclose a material legal or disciplinary event that was critical to an evaluation of the firm’s integrity or ability to meet its contractual commitments to clients. The firm’s principal and control person had been disciplined by FINRA. The proceedings can be found at:http://www.sec.gov/litigation/admin/2011/34-64241.pdf.

Changes in Form U4

Form U4 is a registration and licensing form. Securities regulators use Form U4 to gather information about RIAs and IARs. The goal of the process is to make information available, so investors can make an informed decision about the financial advisor they are hiring.

Just as an RIA must promptly make an other-than-annual amendment in response to material changes, Form U4 must be amended promptly following any material changes or events that occur. RIAs and IARs owe a continuing obligation to amend and update information required by Form U4 as changes occur. Amendments must be filed electronically to update the inaccurate data on Form U4. The filing firm must retain a copy, with original signatures, of the initial Form U4 and amendments to Disclosure Reporting Pages (DRPs). They must be made available for inspection pursuant to a request from regulators.

It is not just disciplinary information that requires updating. Suppose an IAR holds the CFP designation but allows it to become inactive. This type of information must be updated on the U4. Examiners will also be looking for unreported changes in personal information, such as an IAR’s residence, location, and employment.

Investment Adviser Public Disclosure Database

The Investment Adviser Public Disclosure (IAPD) database provides information about current and former IARs and RIAs registered with the SEC and/or state securities regulators. The IAPD database now permits users to search for information regarding IARs. The database provides information such as:

licenses;

professional designations;

examinations passed;

previous employment;

employment within the past ten years, whether inside or outside of the securities industry;

customer disputes; and

disclosure of disciplinary events.

The information found on the IAPD database is collected from Form U4. Therefore, if IARs and RIAs fail to keep these documents updated, investors do not have access to accurate information as they select an investment advisor.

The Big Picture

In a good mystery novel, the plot holds together. The ending makes sense in view of the plot twists that came beforehand. Similarly, Form ADV Part 1 and 2 should be consistent. Examiners should not be reading Part 2 and finding discrepancies with what they have already learned about the RIA in Part 1.

When it comes to disclosure on Form ADV, RIAs should assume that information would be material to investors. If not, the firm might be accused of withholding information under the guise that it is not material to investors. When in doubt, the RIA should disclose information rather than arguing later with securities regulators that it was not material. Since materiality is a rather subjective standard, it’s an argument that the firm is likely to lose.

According to the SEC’s publication, Information for Newly-Registered Investment Advisers, inaccurate, misleading, or omitted Form ADV disclosure is the most frequently cited finding from RIA examinations. It is imperative that an RIA keep the email address of its contact person up to date. The SEC uses this email address to keep RIAs apprised of important regulatory developments.

Les Abromovitz

Les Abromovitz is the author of The Investment Advisor’s Compliance Guide, published by The National Underwriter Company/ALM Media.

An attorney and member of the Pennsylvania bar, Les has handled hundreds of consulting and publishing projects for National Compliance Services, www.ncsonline.com, a leading compliance and regulatory services firm. He has conducted a number of seminars and training sessions dealing with compliance subjects. Les is also the author of several white papers that analyze compliance issues impacting Registered Investment Advisors (RIAs)‎.